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February 18, 2022

Climate trends to watch in 2022

Climate trends to watch in 2022

Global economies and communities are increasingly exposed to dangerous heat waves, damaging storms, deadly wildfires and other extreme climate-driven events. However, in the longer term there is an opportunity to avoid the worst impacts of physical risks by transitioning to net zero by 2050, which is required to limit global warming to 1.5°C by 2100, according to the IPCC. In 2022, we expect: a growing push for accountability on net zero commitments; continued integration of climate risk into financial risk management; development in adaptation finance; and a growing focus on the social dimensions of climate change.

Accountability and action in net zero

A key development at COP26 was the increase in financial sector commitments to address climate change as a systemic risk, including the United Nations Glasgow Financial Alliance for Net Zero’s (GFANZ) pledge that their investments will hit net zero emission targets by 2050. While such commitments signal significant progress, aligning investment portfolios with net zero relies on understanding the emissions trajectories of the underlying companies, as well as the relationship between portfolio-financed emissions and emissions reductions in the real economy.

In 2022, we expect continued growth in forward-looking metrics to assess companies’ pathways to net zero. Based on our Temperature Alignment dataset, only 3% of assessed companies globally are aligned with a future of net zero by 2050 based on their emissions reductions targets, underscoring the need for an increase in both ambition and transparency for net zero targets.

As efforts to reach net zero commitments increase, issuers are embedding their decarbonization targets in innovative sustainable financing structures such as sustainability-linked bonds, which incentivize reaching net zero-related KPIs without restrictions on how funds are allocated. While such mechanisms provide valuable flexibility for issuers striving to reduce their emissions, their transparency and accountability will depend on improved consistency and reporting of KPIs.

Integrating climate risk into supervisory requirements

Climate stress tests are on the rise, and in 2022 we will continue to learn from the results as additional stress tests are rolled out globally for banks and insurers. For example, The Bank of Canada, together with Office of the Superintendent of Financial Institutions (OSFI), recently released the results of its pilot stress test with six financial institutions, finding that delayed policy action leads to higher financial and economic risks. Meanwhile, the European Central Bank released scenarios for its 2022 climate stress tests. These are two examples among many, and continued development of these exercises, as well as improvement in financial risk modeling, will provide essential insight into potential climate risk in the assessed markets, which can inform early mitigation measures.

Climate change is also increasingly integrated into disclosure requirements for companies and investors, with the UK’s climate disclosure mandate for the largest companies and financial institutions scheduled to become law this April. France already has climate risk disclosure laws, and other countries such as New Zealand, Switzerland and Singapore have announced similar plans. Meanwhile, financial regulators globally continue to issue public consultations on principles and mandates related to integrating climate risk into financial risk management expectations, including for banks, insurers and investors. We will see continued development in this space in 2022.

Addressing the adaptation finance gap

The past seven years were the seven warmest on record, with devastating impacts globally. In the near-term, we will continue to experience extreme climate-driven events due to carbon already in the atmosphere, which calls for urgent investment in climate adaptation.

Moody's Sovereign Climate Risk dataset finds that approximately US$41 trillion of the world’s GDP and over 2.4 billion people are projected to be highly exposed to heat stress by 2030-2040, with implications for public health, labor productivity and associated macroeconomic impacts. As the economic benefits of proactively investing in resilience become increasingly clear, the business case for adaptation finance will grow. This presents significant opportunity to investors, from project finance to investing in companies that produce technology and services that contribute to climate resilience, such as early warning systems or water-efficient irrigation.

There is substantial room for growth. For example, we find that to date, sustainable bond proceeds allocated to adaptation and resilience projects have been limited. In 2021 only 3% of green bond proceeds were allocated to climate change adaptation projects, with most proceeds going to mitigation instead, including renewable energy, green buildings and clean transportation. As the green bond market continues to mature and diversify this year, we expect an increase in funds allocated to adaptation, led by sovereigns and other public finance entities with a broader social mandate.

A growing focus on social dimensions of climate change

While the transition to a low-carbon economy presents enormous opportunities in terms of green jobs, improved public health and reduction of long-term temperature rise, the near-term social challenges of the required industrial transformation are increasingly in the spotlight.

The COP26 Just Transition Declaration signals a global effort to harmonize expectations of a just transition to net zero, with more than 30 countries as signatories. Investor coalitions have also formed, including the Investors for a Just Transition group coordinated by Finance for Tomorrow, which represents €4.3 billion of assets under management, and the multistakeholder Financing the Just Transition Alliance, coordinated by the Grantham Research Institute on Climate Change.

Likewise, investments in the infrastructure and workforce needed to power a low-carbon economy must consider the need for resilience to physical climate hazards, which have rippling impacts on public health, labor productivity, and business costs. The communities on the frontlines of extreme weather events are often also confronting overlapping challenges related to environmental justice – such as living alongside coal-fired power plants and refineries – and broader issues, including racial and economic justice. This calls for multifaceted action that addresses both equitable adaptation and the just transition.

Biodiversity and beyond

Biodiversity loss is inextricably connected to climate change, as increasing average temperatures, ocean acidification and other impacts of climate change threaten species, their interactions and their ecosystems. Discussions at COP26 highlighted a growing focus on addressing biodiversity loss alongside climate risks. The development of consistent, comparable measures to capture the multifaceted relationships between companies and biodiversity is at the early stages. However, momentum from 2021 will continue in 2022. The launch of the Taskforce on Nature-related Financial Disclosures (TNFD), which aims to release its initial framework in March 2022, as well as the integration of biodiversity into France’s landmark climate risk disclosure law, now updated as Article 29, show the opportunity to leverage developments in climate risk to propel action on biodiversity. As developments in satellite imagery and geospatial data continue to improve and research continues on the interaction between finance, climate change and biodiversity, our understanding of these multifaceted challenges and their potential solutions will continue to grow.

For more on our outlook for climate, ESG and sustainable finance watch the recording of our ESG and Sustainable Finance Outlook 2022 webinar.